Is emission reduction a new capital?

By Allison Mitkowski

James Cameron admits that he is not a finance guy. He is first and foremost an environmental law and policy expert, a barrister who has dedicated himself to international causes that he thinks will help save the planet from global warming. But in 2004, Cameron — who was instrumental in negotiating the Kyoto Protocol and the UN Framework Convention on Climate Change — took a new approach to combating climate change. Together with Mark Woodall and Gareth Hughes, Cameron co-founded Climate Change Capital (CCC), a London-based investment bank that specializes in opportunities created by the transition to a low-carbon economy in Europe, Asia, and, more recently, the United States.

“We could have called ourselves Cameron, Woodall, and Hughes after the original founders,” says Cameron, who assumed the role of vice chairman upon CCC’s founding. “We could have picked a Greek god or some strange, abstract name. But in the end, we kept coming around to the fact that this was a new, distinct entity that we wanted to stand for something.”

CCC was looking to make a statement during a time when the carbon market was still nebulous. The Kyoto Protocol — which was adopted in 1997 but did not enter into force until 2005 — set mandatory targets for 37 industrialized countries and the European Union for reducing greenhouse gas (GHG) emissions by 2012. (More than 180 countries have ratified it, though the United States has not.) Countries that signed the Protocol must meet their binding targets mainly through domestic measures; however, the treaty offers market-based mechanisms to make compliance more economically efficient. For instance, the Clean Development Mechanism (CDM) enables industrialized countries to invest in projects that reduce emissions in the developing world, where the costs of achieving the reduction can be much lower than in developed regions like the UK. “The only purpose of Kyoto is to reduce climate change, and in that single-minded focus, it uses the market to find the cheapest ways to reduce emissions in the right sequence,” says Paul Bodnar, CCC’s vice president of carbon finance.

While the Protocol regulates six GHGs, CO2 is the principal gas that the Protocol uses as a benchmark for measuring a GHG’s global warming potential. Because the potency of all six GHGs is valued on a carbon-equivalent basis, the financial markets track and trade “carbon” like a commodity, meaning emissions can be securitized as carbon credits that can be bought and sold through national or regional emissions trading schemes.

To generate carbon credits under the CDM, project developers install technology that reduces GHG emissions. The avoided emissions then result in saleable carbon credits. Project developers can also trade the credits to third parties like CCC in exchange for financing or facilitating a CDM project.

CCC’s Carbon Fund (led by Mark Bell, formerly with Deutsche Bank) has over $1 billion to invest in projects that reduce emissions and generate carbon credits. This fund — which is the largest privately held carbon fund in the world — has invested in a variety of low-carbon projects, including wind farms and methane-gas-capture systems. Two of CCC’s China-based project investments are expected to collectively destroy more than 50 million tons of the CO2 equivalent of HFC-23 — an industrial byproduct of refrigerants — by 2012. While HFC-23 is 11,700 times more harmful in terms of global warming potential than CO2, it is not regulated by governments because it has no known harmful effect on humans other than its threat to the climate. However, HFC-23 is particularly valuable in the carbon market because it’s one of the cheapest GHGs to destroy, and its extreme potency makes it worth more credits per ton.

“Our approach was, let’s go after the most potent greenhouse gas, where we could take the largest amount of greenhouse gases out of the atmosphere at the lowest transaction cost,” Cameron says. “That meant doing big deals.”

CCC negotiated with two Chinese chemical companies to build plants that would capture HFC-23 emissions and funnel them into high-temperature incinerators — the only Kyoto-approved method for destroying HFC-23. In return for its role in facilitating these projects, CCC expects to amass carbon credits to sell or trade to governments or companies that are bound by the terms of the Protocol.

“There was some innovation in those deals, because you had to build the plant to do the catalyzing,” Cameron explains. “So in one case, we developed a technology to capture the HFC-23 in a tank before catalyzing it, in order to not waste a second whilst the technology was installed. That’s the kind of thing you do when you have an incentive. There is a time pressure on your money to produce returns to your investors.”

While CCC champions emissions reduction projects as win-win solutions for investors and the climate, critics argue that these projects are merely a cheap and fast way for a limited number of industrialists and financiers to capitalize on global warming with little benefit to the environment, since reductions in emissions in one place are matched by continuing emissions elsewhere.

Cameron tenses when asked about his thoughts on this criticism. His eyebrows furrow and his gaze intensifies as he denounces the detractors in true barrister form. “There are no other means available to us today to motivate a company to cease producing that greenhouse gas,” he says. “We have nothing else. We have no coercive power and very little persuasive power. It is not unlawful to emit this gas, so thank goodness that the Clean Development Mechanism enabled us to have that negotiation.”

“What the market has done is exactly what it should have done, which is to go after large amounts of carbon quickly,” he adds. “The problem that this mechanism is solving is global, and it doesn’t matter where the reduction takes place.”

Bodnar understands this concept all too well. His work at CCC has led him to some of the world’s most desolate regions in search of the biggest polluters.

“I’m one of the guys who gets to visit the most remote factories in China,” Bodnar jokes, recalling a captive power generation project with a cement company in Inner Mongolia. The chemical process of grinding limestone in a kiln causes CO2 emissions, Bodnar explains, and the cement company was looking to capture the heat from the calcining process and turn it into steam to generate electricity, thereby reducing CO2 emissions and decreasing the company’s reliance on the coal-dominated power grid. CCC stepped in and agreed to buy the carbon credits that resulted from the CO2 reduction.

“Our projects are often led by the owners,” Bodnar explains. “They design the systems, but then they need a partner like us to contribute to the financing of the project.”

Bodnar says that CDM projects that capture methane generated by rotting trash in landfills are a particularly effective way for CCC to meet its economic and environmental goals. (Methane is one of the GHGs included under Kyoto and is 21 times more harmful in terms of global warming potential than CO2.) CCC has worked with landfill companies to design and build systems that cover landfills and reroute methane through pipes for combustion in gas turbines. The combustion converts the energy in methane into electricity. Landfill methane capture systems generate carbon credits in two ways: by converting the methane into CO2, and then burning the gas as a form of renewable energy in place of coal or compressing it for use as vehicle fuel. “Just flaring methane would get a 95% reduction to CO2, but you don’t want to waste the resources you have, so you utilize the gas in some way,” says Bodnar.

“There is a lot of creativity that you can apply to this area because there are a lot of ways to reduce emissions that people haven’t even thought of yet,” he adds. “The future is a blank canvas, but we know what kind of picture we want to paint. We want to move to a low-carbon economy, and we want CCC to be a real catalyst in that process.”

While carbon finance deals account for the majority of CCC’s investments to date, the firm is expanding its reach into other areas given the scale of the challenge, and in turn opportunity, that climate change presents. CCC currently manages a 200-million-euro clean-tech private equity fund that in July closed its first deal with a German manufacturer of solar panels, and the firm is looking to further diversify its business strategy into areas like renewable energy and green building development.

“This business has never been and will never be a single bet on the carbon market,” Cameron says. “It’s not ‘Carbon Capital’; it’s ‘Climate Change Capital’ and there are many ways for us to invest and deploy capital at scale into the lower-carbon economy of the future that are not dependent on the carbon market.”